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Markets not pricing in geopolitical tensions

This article first appeared in The Edge Financial Daily, on August 14, 2017.

When American political analyst Brian Klaas said at the start of 2017 that this would probably be the biggest year for political risk since World War II, few would have expected the current level of tension between the US and North Korea. Conservative US radio host Mark Levin even thinks we “may be on the brink of war”.“Rising tension is the best description of the current geopolitical scene,” Institute for Democracy and Economic Affairs chief executive Wan Saiful Wan Jan said of the unprecedented exchange of military threats between Washington and Pyongyang. The situation, he said, was manageable as long as it was limited to “verbal attacks” and did not escalate into a physical war.“The good thing is that a lot of people are trying to avoid a nuclear war,” Wan Saiful told The Edge Financial Daily. “The risk is there but many feel that there is room for reasoning and leaders from other countries are taking steps to persuade both parties to be rational.”Still, while Wall Street has largely brushed aside the US-North Korea war of words as rhetoric, it is not totally ignoring the threat of a nuclear war in deciding where to place its money.The MSCI World Index has fallen by 1.6% from its all-time high of 1,971.76 to 1,940.28 in less than a week following the exchange of threats by the US and North Korean leaders.Interest in gold increased as investors turned to safe-haven assets amid a risk-off mentality which saw the gold spot price rise 5.8% to US$1,288.58 (RM5,540.89) last Friday from a month ago.In Malaysia, the FBM KLCI fell 0.61% to 1,766.96 points while all the indices on Bursa Malaysia were in the red last Friday. On the broader market, decliners outnumbered gainers by 826 to 148.Affin Hwang Investment Bank chief economist Alan Tan said that if North Korea kept to its threats of a missile attack on the US territory of Guam, it would certainly have a very negative impact on the financial markets. Tan, however, said a war was unlikely as there were other ways to resolve the dispute, including getting China to act as a peacemaker.Still, Tan cautioned that the market was not ready if the conflict escalated. “The financial market has not really taken into consideration a potential war when looking at the geopolitical tensions. If that happens, we are looking at a negative surprise as nobody has put much weight on the issue,” he said.The war of words between the US and North Korea is not the only contributor to mounting geopolitical tensions. There is also growing tension over the disputed region in the South China Sea with Vietnam emerging as the most vocal opponent of China’s claims in the waterway.China is also involved in a face-off with India after Indian troops went to Doklam in mid-June to stop a Chinese construction crew from extending a road that would bring China’s army too close to India.Another global conflict is seen from the imposition of new sanctions against Russia by the US that have ended any hope for better ties between the two countries.The Middle East meanwhile is witnessing the worst diplomatic crisis in years after Saudi Arabia, the United Arab Emirates, Bahrain and Egypt cut diplomatic ties and transport links with Qatar in June. This ongoing tension could affect the oil market, especially if the Opec deal to cut supply until 2018 crumbles.UOB Asset Management (M) Bhd executive director and chief executive officer Lim Suet Ling agreed that the market has not priced in the rising political tensions.“I don’t think the market has priced it in. The market is still very complacent at the moment,” she said in a telephone interview.Jameel Ahmad, vice president of corporate development and market research at FXTM, said the market’s recent decline is a reflection of the “risk-off” approach.“At this point, the financial market seems to be pricing more of a premium into the global stock markets. This is not unusual to see, and generally when investors adopt a ‘risk-off’ approach, the stock markets generally encounter selling momentum … the most material theme we have noticed from investors at this point, is safe-haven flows entering the Japanese yen and gold markets,” he said.Mercury Securities Sdn Bhd head of research Edmund Tham said that all the talk of a nuclear war between the US and North Korea would affect sentiment and lead to a knee-jerk reaction.Tham said the local market’s decline so far is only about 1% which is not substantial enough for him to recommend a buying opportunity.As for the ringgit, Jameel said the local currency faced some selling pressure as the tension between the US and North Korea rose, but the losses were not significant.He said the risk-off environment was seen as a threat to the currencies of emerging markets, which was generally why investors will be monitoring the currencies across Asia, including the ringgit.Washington recently successfully lobbied Beijing to vote for additional sanctions on Pyongyang, that cover a ban on the supply of coal, iron and lead.“I think China can do a lot more, yes, China can,” US President Donald Trump said in his briefing on China’s roles to rein in North Korea last Thursday. “And I think China will do a lot more. Look, we have trade with China. We lose hundreds of billions of dollars a year on trade with China. They know how I feel. It’s not going to continue like that. But if China helps us, I feel a lot differently toward trade.”The Trump administration is thus seen to be also using the North Korea issue in its trade war with China. Affin Hwang’s Tan said that with a shift of blame to Beijing, Washington was likely to impose some form of tariff against China. But it was unlikely to be the 45% tariff across the board that Trump mentioned during his election campaign, he said.“Most likely we would see tariffs on selective products or industry if that [shift of blame to China] happens. It will then affect the synchronised global recovery seen at the moment. I think this and a potential war are the two scenarios that the financial market has not priced in,” Tan added.Nomura, in a report in March focusing on the impact of US trade protectionism, said that the value-added of Malaysia’s exports of parts and components to China, either directly or via third countries, that are used as inputs in the production and assembly of finished goods and then exported from China, is about US$12.5 billion.

The report showed that Malaysia has the largest value-added in China’s exports as a percentage of its gross domestic product (GDP) at 4.1%, which reflects the country’s exposure should Trump implement tariffs on China.It also showed that computer and electronics would be the most exposed sector to the tariff measures introduced by Trump. For Malaysia, the value-added in China’s exports of computers and electronics is 2.5% to its GDP, a reflection of the heavy reliance on the electronics sector. This was in line with the latest industrial production index growth data in Malaysia, that was driven mainly by the country’s electrical and electronic products.Last year, Daiwa Capital Markets also ran a report prior to Trump’s presidential election to analyse the impact from a 45% tariff on China, and expected a 4.82% of GDP loss for China.

Latest data provided by the Malaysia External Trade Development Corp showed that total exports to China rose 41.2% to RM59.8 billion in the first half of this year from RM42.3 billion in the same period last year. The contribution of China’s export to the total exports also grew from 11.4% to 13.3% during the same period, indicating a stronger trade with China.It is perhaps too early to consider the risk from these trade barriers given that Trump has been sending mixed messages on his view regarding China so far.However, an analyst with an asset management company pointed that with the rising geopolitical tensions between various countries at the same time, it is perhaps the right moment to consider the likelihood of one of it eventually turning sour.Source: http://www.theedgemarkets.com/article/markets-not-pricing-geopolitical-tensions

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